It’s not all Greek

But beyond Greece, the broader story of recovery continues and should be the focus of investors rather than the noise from the Mediterranean. The ECB, weaker currency and low energy prices have all contributed to the stronger consumer and investor confidence towards European assets in the early part of the year, but some of that optimism has faded in the last couple of months as investors assess whether the momentum can continue at the same pace.

The region has been through a sustained period of improving economic news, in contrast to the US, where until very recently the data has largely disappointed. The Citi Economic Surprise Index, which measures how far actual economic data deviates from estimations, hit its highest level in two years back in the first quarter, but has dipped coming into the middle of the year. That said, the balance of economic reports remains more favourable in the eurozone than in most other developed economies.

A lot of money has flowed into the eurozone on the back of this improving economic outlook and over the last year a healthy overweight towards export-orientated companies and away from domestic-orientated firms will have worked well for many investors. But paradoxically, the weakness in the euro has helped markets much more than the economy, and trade figures have been weaker than perhaps would be expected given the competitive advantage of the depreciation in the euro. The translation effect for companies, however, has been much larger, and exporters have gained. German equities are the clearest example, but the German DAX moved into correction territory last week as some of the shine came off, the euro moved higher and discussions of parity against the dollar faded.

As the regional economy picks up speed and becomes more sustainable, the focus should shift to the long-run potential of the more cyclically orientated sectors. At current valuations, it is difficult to argue against a lot of the good news already being in the price. However, as long as the economic momentum continues, it seems to make sense to tilt any allocation towards the areas of the equity market that are going to benefit from the return to economic expansion, rather than contraction.

With analyst expectations around 20 per cent growth in earnings for this year, the greater potential for upside in company earnings growth compared to other developed equity markets should continue to make the European markets look attractive. Factors such as share buybacks and increasing levels of M&A activity should add support too.

This is all well and good in the near term, but long term, the region – and its financial markets – face many hurdles, with Greece being the most obvious. But Greece aside, the economic and corporate recovery are still at a fairly early stage. Unemployment rates are still elevated in many countries and jobs growth remains a crucial element of the metamorphosis from recovery to longer-run organic growth. Meanwhile, many eurozone governments have limited room to manoeuvre if they are to keep the budget below the 3 per cent gross domestic product threshold. Instead, the focus needs to be on increasing research and development and improving infrastructure as a means to increase productivity and stimulate future economic growth. Unfortunately, this means that policy and politicians will continue to play a significant role in the euro area’s ability to achieve its growth potential – and all the noise that comes with it.

After the stunning performance of European equity markets in the first few months of the year, some moderation of expectations is called for, and we should not expect the rest of the year to be quite as good. But the continued improvement in the real economy, stronger earnings growth and generous dividend yields all suggest that a total return in the low double-digits – and a moderate overweight towards European equities – is justifiable.

Kerry Craig is global market strategist of JP Morgan Asset Management